The Beauty of Municipal Bonds

...only 35 percent of those who reported receiving such interest had incomes of more than $100,000...

...The second, and far more insidious, reform will be disguised as a shutdown of one of the last "loopholes" available to the rich...

...Dan Rostenkowski...

...The court found that registration of bond owners was constitutional, and then unexpectedly threw out the 1895 Pollock v. Farmers' Loan & Trust Co...

...At the time, Christopher A. Taylor, the executive director of the Municipal Securities Rulemaking Board, said that municipal issuers "have now been put on the same footing as other recipients of tax breaks...

...A s it turned out, the stampede was justified...

...If the PSA goes to Washington and tells congressmen that what they're doing is wrecking the ability of municipalities to buildschools, it means one thing...

...But the fact is, only about one-sixth of the debt sold last year ($19.89 billion out of about $116 billion sold) actually went toward infrastructure, and nearly all of it would have been allowed, because it was all traditional, governmental, and public-purpose...

...The first will entail a package of outright regulations on the marketplace, with the seemingly not so subtle intent of punishing rich investment bankers and bond lawyers—although it will be said that such regulations are being used to raise revenues...

...The National Council on Public Works Improvement suggested last October that such spending would just about have to double to keep up with the need...

...A h, the fat cats...

...For those with a taste for the obscure, these include the $2.25 billion Washington Public Power Supply System (WPPSS) bond default in 1983, the biggest ever...

...In Washington the argument is sometimes made that municipal securities are a tax haven exclusively used by the richest five percent of the population...

...Nor could they sell tax-exempt bonds if more than 10 percent of the proceeds were to be used for the benefit of private corporations...

...This is not an extravagant sum to be tossed into the federal coffers, either way, especially if you consider the implications for municipal budgets...

...But if, as Fred Barnes has commented in these pages, conservatives have to get it through their thick skulls that Americans like big government, it seems that it would be far better to keep as much of that government as possible at the state level...

...As House Speaker Jim Wright told some investment bankers and issuers last year, "Everything is fair game," including killing altogether the tax-exemption that issuers enjoy...

...The size and character of the tax bill will determine the size and character of the hit," he says...

...They're going to target the buy-side," says Austin V. Koenen, a managing director at Shearson Lehman Hutton Inc...

...The argument is spurious on the face of it, but symptomatic of a certain mentality...

...Many in Congress have already been led to believe that tax-exemption is just one more inefficient form of federal handout, and they are more than eager to take over distribution of the cash...

...They will also talk about abuses in the $729 billion (outstanding debt) municipal bond market...

...The Congressional Joint Committee on Taxation, for example, figured restrictions on the bond market would raise a paltry $695 million of tax revenues over five years...

...As another congressional staffer once put it, "You [bond] guys are your own worst enemies...

...Before tax rates are increased, all tax preferences will be hit hard...

...They could no longer sell tax-exempt securities to finance construction of parking garages, stadiums, convention centers, and industrial parks...

...John F Kerry of the same state, whose political bona fides are well known, five years ago gave one of the most effective speeches on the need to preserve tax-exemption...

...The tax code also set up a blinding array of rules governing such market esoterica as how much issuers could pay printers, lawyers, and investment bankers to put certain kinds of bond issues together...

...But, fueled at every stage by the creativity of investment bankers seeking to outwit tax law, by tax reform, or by justifiable fears of tax reform, the total grew to $132.95 billion in 1984 and a record $223.45 billion in 1985, when fears of whatever Congress was cooking up in its tax reform act created a stampede to market...

...The court said in no uncertain terms that states have no constitutional right to sell bonds that are tax-exempt...

...C ongressmen, with a few notable exceptions, don't have the foggiest idea about what tax-exempt bonds are—even if they hold them in their own portfolios...

...Simply put, municipal bonds are the securities sold by municipalities (the term includes everything from a village or specially created authority to a state) to fund the construction of roads, bridges, schools, housing, reservoirs, and sewers, among other things...

...The Court's decision was 7-1, with Justice Sandra Day O'Connor dissenting in words that may serve as a battle cry for municipalities...

...He succeeded not only in cutting the state's deficit, but also in getting its credit rating upgraded...

...When even House Republicans talk about another tax bill, you can believe that there will be another one coming...

...America's invariably "crumbling" infrastructure...

...They had all the numbers, all right, but they were, remember, "these, these rich" Wall Streeters...

...The staffers who come up with new prohibitions this year will talk about more than just raising revenue...

...To declare that now, for some reason, the locals shouldn't decide what they should and should not finance smacks of the worst sort of Inside-the-Beltway elitism...

...The alternative is the continued centralization in Washington of whatever power the states have left...

...The amount of student-loan, industrial-development, and housing bonds they could sell was also limited by a formula based on population...

...Municipal bonds are boring and, with a few exceptions, nice: the financial equivalent of the girl next door...

...Bob Packwood in an unforgettable outburst, could do little but sputter about "these rich, a handful of the richest law firms" and so on, apparently mistaking the investment bankers and bond lawyers who work in public finance for the high rollers in merger and acquisition work...

...In 1985, when investment bankers stormed Capitol Hill, the pols, including Sen...

...Justice O'Connor wrote in her dissent, "If Congress may tax the interest paid on state and local bonds, it may strike at the very heart of state and local governmental activities," and increase their dependence on the federal government...

...The icing on the cake was the placement of a tax on the interest of certain issues, thereby making hitherto "tax-exempt" bonds taxable...

...The truth of the matter, however, is that the municipalities might well be forced to sell a small portion of a bond issue—a tail, if you will—carrying higher, taxable yields, to pay those costs...

...Be wary of Treasury and congressional staffers assuring you that there is no agenda of bond-bashing...

...He's come to Wall Street to see bond rating agencies and make his case, and now that he has the President's ear, Sununu may be the point man for states' rights to tax-exemption, for the simple reason that he understands what it all means...

...In 1981, when I started covering the municipal market, the sleepy days were still with us...

...Ignorance of municipal bonds in general, and their benefits in particular, is nonpartisan...

...She concluded: "The Court has failed to enforce the constitutional safeguards of state autonomy and self-sufficiency that may be found in the Tenth Amendment and the Guarantee Clause, as well as in the principles of federalism implicit in the Constitution...

...Infrastructure, as defined by the council, includes roads, bridges, mass transit, airports, and water, sewer, and solid waste plants...

...You never get any significant gain in revenues from bond curbs—you gain the revenue strictly over time...

...of Delaware reintroduced his proposal for a constitutional amendment to prevent the federal government from taxing the interest earned on governmental bonds used for public purposes, a proposal narrower than asking for a constitutional guarantee on states' rights to tax-exemption, but at least a move for some protection...

...Municipalities sold $67.86 billion in securities, both long and short term...

...It was, I later learned, drafted for him by an investment banker...

...If a state treasurer, or a mayor, or a governor goes to the Capitol and, using the PSA statistics, starts yelling about the evils befalling the constituency back home, it is quite another matter...

...they were decided at the hometown level, and usually by referendum...

...20 THE AMERICAN SPECTATOR JUNE 1989...

...In 1986, the amount of tax-exempt bonds and notes sold dropped precipitously, to $162.65 billion, and further, to $114.16 billion in 1987...

...If the Congress is not concerned, or is too busy to learn about what the tax-exempt issue really is all about—the reallocation of local power to the federal government—we could see unelected gnomes on tax committees and in the Treasury and the IRS deciding who will get a municipal swimming pool, and who will get their roads paved...

...John Sununu, when he was governor, presided quietly over what was never referred to as the New Hampshire miracle, although unlike the one across the border in Massachusetts it is still in full vigor...

...On both counts, you would be wrong...

...PSA estimates that if tax-exemption were removed, it would cost issuers $264 billion extra in interest costs between now and the year 2000...

...The Tax Reform Act of 1986 was a comprehensive document that tightened the screws andprecisely limited what municipal issuers could do...

...When the federal income tax was born in 1913, interest on the issues was exempted based on the principle of "reciprocal immunity'—the federal government did not tax the interest on the bonds sold by municipalities, and the municipalities did not tax the interest on the bonds sold by the federal government...

...and at least $50 billion in sham bond deals put together in 1985 and 1986 (one of them a $300 million bond issue designed for housing—on the Pacific island of Guam), currently under investigation by the Securities and Exchange Commission...

...Issuers and their organizations, and the PSA, have stepped up their lobbying efforts on this point, for it goes to the heart of the industry...

...What Justice O'Connor marked, then, was a fundamental change in constitutional philosophy—that all good, and all benefits, devolve from the State...

...Congress will be hunting for added revenues next year, and I'm afraid this means that tax-exempt bonds will be like a plump duck flying over the hunting grounds...

...So if the tax-exempt bond market were used to finance infrastructure needs exclusively, it might only amount to $40 billion or so a year...

...The big buzzword this year—as in recent years—is infrastructure, and how much municipalities will have to spend to repair what they call their physical plant...

...They had to set up allocation systems to decide who would get how much of their states now-limited industrial-development, student-loan, and 18 THE AMERICAN SPECTATOR JUNE 1989 housing bonds, and they had to set up new accounting procedures to track arbitrage earnings...

...Last April, in a little-heralded decision (of course, it was big news for us at the Bond Buyer—but then again, we also get excited talking about the Minnesota 50 percent coupon and the definition of Canadian Interest Cost), the Supreme Court decided that the 1982 South Carolina v. Baker case challenging the mandatory registration of the owners of tax-exempt bonds...

...But more on the deviltry toward investors, the "buy-side" of the market, later on...

...To talk about the benefits of tax-exempt finance was, in the mindset of those in the Imperial Congress, not only confusing and boring, but also self-serving...

...The stuff to limit cost of issuance is just a drive to get what they perceive as the fat cats," says McEvoy...

...A recent Internal Revenue Service study showed that tax-exempt securities are held by taxpayers of all incomes, not just "the rich...

...As a matter of fact, one top congressional staffer did assure me this year that bonds were not on the agenda "in any substantive way—in strictly marginal ways, perhaps...

...and vice chairman of the PSA...

...McEvoy, however, still sticks by his guns...

...For the fact is that while these bond boys do put some pretty nice numbers on the board, theirs, for the most part, is not the wealth of, say, Sherman McCoy in The Bonfire of the Vanities...

...You can, of course, make a nice living doing so...

...Competition is such in the municipal market today that more than one exasperated banker has said to me, "I don't know how anyone is making money underwriting bonds today...

...And the bond provisions written by tax staffers are generally so complicated, and make up such a small part of any tax bill, that it isn't until the telephones start ringing off the hook that they pay much attention to what they might be approving...

...Daniel Patrick Moynihan, for example, a successful politician savvy in the ways of running cities, knocked a draconian measure to tax all bonds out of a Senate tax package a few years ago—but only after its more damaging aspects were called to his attention in an agonized outcry by New York issuers and dealers...

...In the past couple of years, however, the bankers have gotten a little cannier, and now provide the issuers, who themselves are now a little angrier, with the ammunition to put together a decent lobbying effort...

...Get ready for another whack at tax reform...

...There is, moreover, the prospect of Congress doing away with tax-exemption altogether...

...Another possibility is a limit on 501 (c)(3) bonds, or those issued for private, nonprofit entities, like hospitals and colleges...

...But using infrastructure as the argument for why bonds are good things is as specious as the argument for eliminating all so-called private-activity bonds...

...I don't know of many other industries where the top firm in the business suddenly decided to quit because the business was not lucrative enough, which is what happened in October 1987, when Salomon Brothers opted out—one week before the stock market crash...

...yet Sen...

...Any conservative, nonpartisan defense of tax-exempt bonds is based on the fact that at certain points during this century it was decided that it was good public policy to sell tax-exempt bonds for a variety of purposes, including prisons, stadiums, housing, advance refunding for interest rate savings, pollution-control equipment for factories, and a host of private projects...

...You would think that the "New Federalism," when introduced by Ronald Reagan eight years ago, meant that municipalities would be left alone, and even encouraged, to finance whatever they need on their own...

...While Congress and the Treasury had been making laws pretty much disregarding the "precedent," the constitutional safeguard argument was always there—sort of a security blanket for the market...

...This is why you have to figure getting that $695 million, or $7.4 billion, over five years...

...So much for federal concern with crumbling infrastructures...

...The tax-exemption means that municipalities save at least two points-200 basis points, in bond jargon—more on their borrowings than do corporations, which sell taxable debt...

...Conservatives may be naturally averse to anything "public...

...John McEvoy, director of the National Council of State Housing Agencies and former staff director of the Senate Budget Committee, is a familiar figure on the municipal bond speakers' circuit, and what he says carries some weight...

...Those matters of good public policy were not decided by judges, or federal legislatures, or unelected aides to those legislators...

...The Treasury, meanwhile, where so many good tax ideas originate when they do not come out of Congress's tax-writing committees, put the figure closer to $7.4 billion, over the same five years...

...And as for the sham deals and other abuses—usually having to do with super-aggressive salesmen in boiler rooms selling questionable bonds to widows and orphans—these are the kinds of things handled not by Congress but by the SEC, the Internal Revenue Service, the Treasury Department, the National Association of Securities Dealers, and the Municipal Securities Rulemaking Board...

...The bankers and issuers have risen to the occasion on this one, surprisingly enough, because they know that this is where the battle will be joined...

...It's not over," he predicted last January...

...S much for the proposed curbs...

...The most "conservative" approach "Beware of Treasury and congressional staffers assuring you that there is no agenda of bond-bashing...

...The investment bankers have to demonstrate that what they're doing is worth the money, and that what the cities and towns are doing is worth the money...

...And, under the right pressure to find "revenue-raisers," Congress is capable of "just about anything" this time around, say lobbyists, which might mean the end of tax-exempt municipal bonds, under fire for most of this decade...

...Infrastructure financing" is being used as a shield, and wrongly, by some market participants to defend all public finance...

...Before you're sold on the evils of top-hatted investment bankers who regularly dine on the babes of the poor, consider that the WPPSS default (recently settled with bondholders for a little less than fifty cents on the dollar) was created by a Washington State court decision that voided a batch of municipal contracts...

...Accordingly, three states have already passed resolutions for a constitutional amendment to guarantee the tax-exemption of their municipal bonds, and another three are considering them...

...Then again, you would also think that the "New Federalism," when introduced by Ronald Reagan eight years ago, meant that municipalities would be left alone, and even encouraged, to finance whatever they need on their own...

...The municipalities borrow the money for periods ranging from a few months to thirty years or more...

...Tax-exempt bonds are nobody's child, despite all the lip service you hear paid to Joe Mysak is managing editor of the daily Bond Buyer...

...But Congress, as one staffer told me, "has a natural prejudice against anyone who has money...

...The new outrages on the tax-exempt bond market will come in a number of ways...

...But when the bond lawyers of the National Association of Bond Lawyers, and the investment bankers in the Public Securities Association (PSA), showed up on Capitol Hill in 1985, congressmen saw red...

...Under that early Treasury proposal, traditional, governmental, public-purpose financing would have been retained...

...The more technical prohibitions that might be put forth in the second half of the year concern "cost of issuance": for example, an arbitrary limit (two percent) on how much municipalities may pay to cover costs attendant to the sale of their bonds (printing, legal fees, and so forth) to all bonds, not just those being used to subsidize "private activities...

...So get ready for another whack at tax reform...

...They will have to get in line with the others to argue their case for continuing to receive special treatment...

...THE AMERICAN SPECTATOR JUNE 1989 19 to tax reform was concocted by the Treasury in 1984, which suggested at its core a semi-flat tax with a top marginal rate of 35 percent, and proposed weeding out virtually all public financing designed to help private interests, which, among other things, would do away with public airport authorities building terminals for Delta Airlines, and Harvard selling tax-exempt bonds for new dormitories...

...You would think that such instruments would be natural for conservatives to defend...

...And this can amount to a tidy sum...

...1. 3 Another idea apparently circulating in Washington—although this is publicly (and vehemently) denied by the Treasury and almost everyone else—is an assault on the buyers of tax-exempt bonds: a limit on how much tax-free income any one taxpayer might deduct from gross income...

...The amount of financing done would have been cut by two-thirds...

...No doubt congressmen think they arehelping municipalities when they tell them that they cannot pay more than an arbitrarily selected amount for certain services...

...Kindly, Speaker Wright added: "It's nothing personal...

...The third will be killing tax-exempts altogether...

...Brian Donnelly, Democrat of Massachusetts, whose ADA rating is creeping ever higher, is a member of the House Ways and Means Committee and author of some nasty bond curbs on the docket this year...

...It also stipulated how quickly they would have to spend the money they raised by selling bonds, and eliminated any investment earnings they might make on money they did not immediately use—in other words, under the new law, if you sold bonds and paid your investors seven percent interest, you could not turn around and invest the money in bonds sold by the U.S...

...And in January, Sen...

...Nor is Democrat Rep...

...Republican Senator Packwood, to repeat, is no friend of tax-exemption...

...One-third of the taxpayers who reported receiving tax-exempt interest in 1987 had annual incomes of less than $50,000...

...Even the House and Senate considered this a tad too dramatic...

...Treasury and carrying a nine percent yield...

...William Roth, Jr...

...case, which gave birth to the doctrine of reciprocal immunity...

...The result of all of tax reform's sausage-making last time was precious little, at least when it comes to bringing in the cash, and depending on who cooks the numbers...

...The part of tax reform dedicated to municipal finance thus served to make miserable the lives of issuers—meaning the people in a score of such organizations as the National Association of State Treasurers, the Government Finance Officers Association, the National League of Cities, and the Council of Infrastructure Financing Authorities...

...The new law also eliminated certain deductions taken by banks and insurance companies when they buy bonds...

...These are glimmers in otherwise bleak days...

...Perhaps the real ace in the hole for the partisans of tax-exemption is in the White House, in the person of the President's chief of staff...